Why The Fiscal Cliff Is Going to Blow

Flat Spin

Watch the spin machine go into overdrive now…

The day after a hard-fought election that left Barack Obama in the White House and control of Congress divided between the two parties, the nation’s political leaders promised to try to avoid year-end spending cuts and tax increases that threaten to push the U.S. back into recession.

In carefully worded comments Wednesday, major actors in the fiscal drama were both conciliatory to their adversaries and resolute in sticking to their principles. Whether this represents a temporary truce, or a step toward a pact to trim the deficit, won’t be known for weeks.

Here’s what it is, and it’s shameful the WSJ won’t call it by its true name: Total crap.

This is a matter of arithmetic more than it is politics.  And the arithmetic is quite-clear when you boil down what’s being said and what reality is.

We must go back to arithmetic, because it is there that one finds the truth.

GDP = C + I + G + (x – i)

That is, GDP = Consumption + Investment + Government Spending + Net Exports

Note that this alleged “measurement” is inherently flawed, however, because it is a nominal value.

That is, if we have 10,000 units of credit and currency in the system and we add 1,000 units through deficit spending,GDP increases even though from the common man’s perspective who is not a recipient of the government largesse he actually saw his economic prosperity in real terms decline! 

But even the recipient of the largesse did not see an actual gain, although one was reported — he saw “status quo.”  That is, he saw “more” but each unit of currency and credit bought less, and those more-or-less cancel out.

To “fix” the fiscal cliff you must stop deficit spending, one way or another.  And there is no free lunch — if you increase taxes then either “C” (consumption) or “I” (investment) must decline since the money to pay the taxes has to come from one of those two categories.  If you cut government spending then GDP decreases by the exact amount that “G” is decreased.

When “growth” in GDP is 2% a year but you are deficit spending 8% then the real economic growth is -6%.  If you stop the deficit spending, no matter how you do it, the true economic rate of change becomes exposed irrespective of how you do it.

This is what our true economic growth rate has looked like in recent years (the red line, my friends, the red line):

At present run-rates this year looks to be coming in at $1.246 trillion, effectively identical to last year in terms of the calendar-year deficit (which was $1.225)  while nominal GDP appears to have not changed much either, although we do not yet have current figures and won’t for the last two quarters until early 2013.

But — this chart shows you the problem quite-clearly: We haven’t had a materially-positive GDP value in real terms — that is, over 2% — since 2000!

This, when you boil it all down, is the problem.  The government, both Republicans and Democrats, have “discovered” that they can fake “economic growth” by running fiscal deficits!  This in turn results in nominal GDP values that look much better than the truth really is, and that in turn spurs people to do foolish things, such as spending money and increasing leverage into what is a factually-deteriorating economic picture.

If you think either of the parties is going to voluntarily step back from this and recognize the truth, you’ve been smoking too much of that whacky weed that was just legalized in Colorado.

Until we, as people, demand that our government tell the truth when it comes to economic statistics, reporting GDP ex-fiscal deficit spending so as to neutralize the ability of the government to game the numbers with this fraudulent and intentionally-false reporting there is no solution other than that which will be imposed by the market.

Discussion (registration required to post)